Request for Indemnification Under BCL Denied on Procedural Grounds

On July 13, 2017, Justice Emerson of the Suffolk County Commercial Division issued a decision in Federico v. Brancato, 2017 NY Slip Op 50968(U), denying a request for indemnification under the Business Corporation Law on procedural grounds.

First, the court reviewed the legal framework for the indemnification of officers and directors under the BCL:

Business Corporation Law § 722 is permissive in that it allows, but does not require, the corporation to indemnify directors and officers as long as the prescribed standard of conduct is satisfied. Under § 722(a), a corporation may indemnify an officer or director who is made a party to a civil action or proceeding against judgments, fines, amounts paid in settlement and reasonable expenses, including attorney’s fees actually and necessarily incurred as a result of such action or proceeding, or any appeal therein, if such director or officer acted, in good faith, for a purpose which he reasonably believed to be in the best interests of the corporation. In the context of derivative actions, § 722(c) provides that a corporation may indemnify officers and directors who acted in good faith and in the best interests of the corporation against amounts paid in settlement and reasonable expenses, including attorney’s fees, actually and necessarily incurred by them in connection with the defense or settlement of such action.

A director or officer who has been successful on the merits or otherwise is entitled to indemnification for the defense of any civil action against him. This type of indemnification has been termed mandatory indemnification because the corporation does not have discretion whether or not to grant it. Any outcome that does not result in a finding of liability is considered a success for purposes of this subsection.

Notwithstanding the failure of a corporation to provide for indemnification, and despite any contrary resolution of the board of directors or of the shareholders, indemnification may be awarded by a court to the extent authorized by the statutes. No indemnification may be awarded by a court, however, if it would be inconsistent with a corporate provision disallowing indemnification, or otherwise limiting it, in effect at the time of the accrual of the cause of action asserted in the action or proceeding in which the expenses were incurred or other amounts were paid.

For a corporation to grant permissive indemnification under § 722, a determination must be made that the director or officer’s conduct has conformed to the requisite standard of conduct by one of the following procedures: (1) a vote by a quorum of directors who are not parties to the action or proceeding, (2) a written opinion by independent legal counsel or by the board based on an opinion by independent legal counsel, or (3) shareholder approval. The statutory scheme does not specify any procedure that must be followed to grant mandatory indemnification, but merely provides that, when an officer or director has been successful on the merits or otherwise, he shall be entitled to indemnification. Resort to a court for indemnification is authorized when the corporation has failed to provide for indemnification on a voluntary basis under § 722 and when indemnification has been refused by the directors or shareholders in a specific case under § 723.

Next, the court addressed the application before it:

The instant motion is premature insofar as the Senior Brancatos seek indemnification for the $475,754.52 in legal fees and expenses that they have already incurred in defense of this action. The record does not reflect that the Senior Brancatos sought indemnification from Challenge Graphics prior to making this motion. Moreover, the motion was not made on notice to Challenge Graphics, as required by Business Corporation Law § 724(b). It, therefore, cannot be determined from the record presently before the court whether indemnification would be inconsistent with a corporate provision disallowing indemnification, or otherwise limiting it, in effect at the time of the accrual of the causes of action asserted by the plaintiff.

The Senior Brancatos also seek an advance of legal fees and expenses in the amount of $75,000.00 for anticipated legal fees and expenses from February 1, 2017, until the conclusion of this action. When indemnification is sought by judicial action, Business Corporation Law § 724 (c) authorizes the allowance of necessary litigation expenses during the pendency of the action if the court finds that the defendant has, by his pleadings or during the course of litigation, raised genuine issues of fact or law. Here, the issue of liability has already been determined, and the issue of damages is determined simultaneously herewith. The action is, therefore, no longer pending. Accordingly, the motion is denied.